Financial and Managerial Accounting John J. Wild Third Edition John J. Wild Third Edition McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 12 Reporting and Analyzing Cash Flows

Conceptual Learning Objectives C1: Explain the purpose and importance of cash flow information. C2: Distinguish between operating, investing, and financing activities. C3: Identify and disclose noncash investing and financing activities. C4: Describe the format of the statement of cash flows. 12-3

Analytical Learning Objectives A1: Analyze the statement of cash flows. A2: Compute and apply the cash flow on total assets ratio. 12-4

Procedural Learning Objectives P1: Prepare a statement of cash flows. P2: Compute cash flows from operating activities using the indirect method. P3: Determine cash flows from both investing and financing activities. P4: Appendix 12A: Illustrate use of a spreadsheet to prepare a statement of cash flows. P5: Appendix 12B: Compute cash flows from operating activities using the direct method. 12-5

How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? Purpose of the Statement of Cash Flows C1 12-6

How did the business fund its operations? Did the business borrow any funds or repay any loans? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? Importance of Cash Flows A1 12-7

Cash Currency Cash Equivalents Short-term, highly liquid investments. Readily convertible into cash. Sufficiently close to maturity so that market value is unaffected by interest rate changes. Short-term, highly liquid investments. Readily convertible into cash. Sufficiently close to maturity so that market value is unaffected by interest rate changes. Measurement of Cash Flows C1 12-8

The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities Classifying Cash Flows C

Outflows Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Other Outflows Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Other Inflows Receipts from customers Cash dividends received Interest from borrowers Other. Inflows Receipts from customers Cash dividends received Interest from borrowers Other. Operating Activities C

Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Other Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Other Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans Other Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans Other Investing Activities C

Outflows Pay dividends Purchasing treasury stock Repaying cash loans Paying owners’ withdrawals Outflows Pay dividends Purchasing treasury stock Repaying cash loans Paying owners’ withdrawals Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Financing Activities C

Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred stock to common stock. Leasing of assets in a capital lease transaction. Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred stock to common stock. Leasing of assets in a capital lease transaction. Noncash Investing and Financing C

Format of the Statement of Cash Flows C

There are two acceptable methods to determine Cash Flows from Operating Activities: Direct Method Indirect Method There are two acceptable methods to determine Cash Flows from Operating Activities: Direct Method Indirect Method Format of the Statement of Cash Flows C

Let’s look at the Indirect Method for preparing the Cash Flows from Operating Activities section. Preparing the Statement of Cash Flows P

Net Income Cash Flows from Operating Activities 97.5% of all companies use the indirect method. Changes in current assets and current liabilities. + Losses and - Gains + Noncash expenses such as depreciation and amortization. Indirect Method P

Use this table when adjusting Net Income to Operating Cash Flows. Indirect Method P

 East, Inc. reports $125,000 net income for the year ended December 31,  Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.  During 2009, East reported $12,500 of Depreciation Expense.  East, Inc. reports $125,000 net income for the year ended December 31,  Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.  During 2009, East reported $12,500 of Depreciation Expense. What is East, Inc.’s Operating Cash Flow for 2009? Indirect Method Example P

Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities For the indirect method, start with net income. Indirect Method Example P

Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense. Indirect Method Example P

Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Indirect Method Example P

Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Indirect Method Example P

Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities. Indirect Method Example P

Let’s prepare a Statement of Cash Flows for B&G Company using the Indirect Method. Indirect Method P

P

Additional Information for 2009: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash. Additional Information for 2009: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash. P

Add noncash expenses and losses. Subtract noncash revenues and gains. Add noncash expenses and losses. Subtract noncash revenues and gains. Start with accrual-basis net income. Then, analyze the changes in current assets and current liabilities. P

P

Now, let’s complete the investing section. P

Now, let’s complete the financing section. P

P

Analyzing Cash Sources and Uses A

Used, along with income-based ratios, to assess company performance. Cash flow on total assets = Operating cash flows Average total assets Cash Flow on Total Assets A

Let’s look at the Direct Method for preparing the Cash Flows from Operating Activities section. Preparing the Statement of Cash Flows P

Analyzing the Cash Account Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows under the Direct Method. P

P5 Preparing the Statement of Cash Flows – Direct Method 12-37

End of Chapter